The Eurozone Must Not “Move Forward”

Suppose you are headed home and your GPS leads you down a blind alley. A dead end. A cul de sac. What do you do next? One solution would be to back out and take another route. But the alley is narrow and hence backing out would be difficult. So you decide to “move forward.” Get the pick axe and shovel out of the trunk, and start demolishing the buildings that are blocking your path.

The policy elite of Europe thought it would be a great idea to have a single monetary unit for 17 different countries, which have very different policy needs. This was to be done through the wise leadership of unelected technocrats, who would put aside all messy political calculations and focus single-mindedly on low inflation. Unfortunately things didn’t work out, just as all previous attempts to put multiple economies into a fixed exchange rate straight-jacket eventually failed.

So do they propose abandoning the experiment? No. Many of the same people who brought us the euro now want to double-down on some sort of fiscal union, which might involve eurobonds. Fiscal union would be like the euro on steriods. All the current problems would be multiplied 10-fold. German taxpayers would be asked pay for wasteful government programs in Greece and Sicily, even as German voters would have no say in how the money is spent. That’s a recipe for non-stop discord, for a revival of nationalism. Recall that the taming of nationalism was the central political goal of the EU, which was created to prevent a repeat of the horrors that Europe experienced in the first half of the 20th century.

The beauty of the EU is that it’s currently a highly decentralized system, with EU spending being somewhere around 2% of GDP. It’s sort of like the US federal government in the 1920s. Now you might complain that the 1920s was followed by the Great Depression. That’s right, and that’s why faster NGDP growth is a necessary condition for any sort of resolution of the debt crisis. (I say necessary, not sufficient.)

Many people seem to be under the illusion that Germany is a rich country. It isn’t. It’s a thrifty country. German per capita income (PPP) is more than 20% below US levels, below the level of Alabama and Arkansas. If you consider those states to be “rich,” then by all means go on calling Germany a rich country. The Germans know they aren’t rich, and they certainly aren’t going to be willing to throw away their hard earned money on another failed EU experiment. That’s not to say the current debt crisis won’t end up costing the German taxpayers. That’s now almost unavoidable, given the inevitable Greek default. But they should not and will not commit to an open-ended fiscal union, i.e. to “taxation without representation.”

In addition to not being rich, Germany is fairly heavily taxed, like all other Western European countries. If taxes were at US/Japanese/Australian levels, it might be possible to extract more revenue without killing the goose that lays the golden egg. Even at current German tax levels it may be possible to extract a bit more revenue. But there is certainly much less room for maneuver.

The EU must not move forward, it must move backwards. That’s because the EU in the 1990s was a much sounder institution. If it ain’t broke, don’t fix it. The European Monetary System circa 1998 wasn’t broke, and should not have been fixed.

Scott Sumner has taught economics at Bentley University for the past 27 years.

He earned a BA in economics at Wisconsin and a PhD at University of Chicago.

Professor Sumner's current research topics include monetary policy targets and the Great Depression. His areas of interest are macroeconomics, monetary theory and policy, and history of economic thought.

Professor Sumner has published articles in the Journal of Political Economy, the Journal of Money, Credit and Banking, and the Bulletin of Economic Research.